Long term unsolicited credit rating at level A+. The agency expects a stable outlook for the following 12 months. The rated entity was notified on October 3, 2018, about the rating and after the notification there weren’t changes or amendments in the rating. This is a first release of the rating for distribution.

The credit rating assigned to Slovakia stems from the European Central Bank’s debt guarantee, strict fiscal rule, and high assessment of governance and economic stability. The national fiscal rule, which is even stricter than the European one, is tightening. The rating is restricted by a moderately high debt load and low export diversification. Inadequate export diversification makes the economy vulnerable to trade restrictions.

Rating components

Macroeconomic factors

Economic factors

High

Debt and current account factors

High

Public finance factors

Moderate

Private finance factors

Moderate

Foreign dependency factors

Very high

Liquidity factors

Very high

Final assessment

High

Forward-looking factors

Political and economic stability

High

Efficiency and reforms potential

High

Final assessment

High

Overall score

High

Final rating

A+

Macroeconomic factors of rating assessment

The Slovak economy has somewhat above average growth perspectives in the medium term, elevated susceptibility to external demand shocks, and as a member of Eurozone, access to sufficient mechanisms to compensate it.

Growth perspectives of an above average developed country:

Being a country of GDP per capita and labor productivity lower than European average, Slovakia will most probably grow at catching-up rates closer to developing countries. Higher growth rates of real GDP, above 3.5%, are expected in the medium term due the smooth transfer of capital and technology within the EU. Nevertheless, longer-term potential GDP growth estimates are close to 2%, which stems mainly from negative labor force dynamics and low expenditures on R&D.

Automotive sector orientation of exports makes the economy vulnerable to sector specific shocks, such as the threat of tariffs on US, and in the case of a hard Brexit scenario, UK imports as well. The sector accounts for more than a quarter of the country’s exports. In the longer term, the sector is expected to undergo major changes due to the increasing penetration of electric vehicles, growing shared economy and the emergence of self-driving cars. Failing to respond to these challenges would have a negative impact on economic growth and employment.

Nevertheless, Eurozone membership substantially reduces the likelihood of fiscal and balance of payments problems. A number of mechanisms to tackle potential challenges have been created since the debt crisis, including the conditional guarantee of government debt by the European Central Bank. It was launched in 2012, at the height of the debt crisis, and allows unlimited purchases of government-issued bonds that mature in 1 to 3 years, provided that the bond-issuing countries agree to certain domestic economic measures. This measure dramatically reduces the risk of the government’s default on in its debt. With relatively low and declining government debt levels, Slovakia is unlikely to use these mechanisms in the foreseeable future.

Tightening of the fiscal rule:

According to the national fiscal rule approved in 2012, debt limit starts tightening gradually in 2018. The sanction band for the government debt is automatically declining by one percentage point every year from 50-60% GDP to 40-50% by 2027. In the case that the debt is in the sanction´s bands, the government is obliged to report what measures are being taken to reduce the debt amount. It limits the room for the government to increase expenditures when inside the bands. In 2017, the Slovak government debt stood at 50.9% GDP. With fiscal deficits below 1% of GDP and a strong economy, we expect the government debt to decline below the sanction´s bands until the end of 2019.

Household debt growth and countercyclical measures:

Common monetary policy in the Eurozone creates the risk of excessive credit growth, which might jeopardize the banking system’s stability and lead to costly government bailouts. The ECB policy is too expansionary for the current stage of the economic cycle in Slovakia. As a result, the growth of household debt to GDP ratio in Slovakia is the highest in the EU. Since 2010, it has grown by approximately two thirds to above 40%. Although this is below the average of the EU (52.7%) it is the highest among the former Eastern Bloc countries of the union, where the household debt to GDP levels were extremely low at the start of the economic transformation in the early nineties.

The risk stemming from the rising household debt remains low in our view. Firstly, the central bank is committed to counter the credit expansion and to limit the potential impact on the banking sector. It has already tightened the rules for mortgage origination to mitigate the credit growth and increased the counter cyclical buffer for banks.

Secondly, the growth of indebtedness has not created any high distortions in the housing market yet. The ratio of average wage to the average price for a square meter in an apartment is almost 25% below its peak from 2008.

Household debt to GDP ratio and apartment price to income ratio

Sources: Eurostat, National Bank of Slovakia

Forward-looking factors of rating assessment

High level of most governance indicators, but lower control of corruption and R&D spending

Low R&D spending:

In 2016, Slovakia spent only 0.79% of GDP on research and development, which is well below the average of the Visegrad Group countries, which stands at 1.16%. Inadequate funding and research facilities are contributing to brain drain, which is also worsened by the free movement of labor within the EU. In the case of persisting low R&D spending, the innovative capacity of the economy will not be sufficient enough to support higher economic growth after the current catch-up phase.

Above average governance indicators except for control of corruption

Slovakia scores above average in the World Governance Indicators released by the World Bank. It achieved a very high score in political stability. However, the control of corruption is below average. This implies elevated rent-seeking in the economy, which is a drag on the allocation of resources in the economy and thus on the potential economic growth.

Selected World Governance Indicators (ERA score, 1-10):

Source: World Bank, ERA

Outlook: Stable

The outlook has been assigned based on expectations of political stability in the Eurozone and continued government adherence to the fiscal rule.

The Stable outlook assumes that the rating will most likely stay unchanged within the 12-month horizon.

Key assumptions

Government’s adherence to the fiscal rule

Continuation of the ECB’s conditional guarantee of government debt

Real GDP growth is expected to pick up to above 4% in the medium term

Potential outlook and/or rating change factors

A positive rating action may be prompted by:

Substantial decline in government debt to levels below the lower bound of the sanction band of the fiscal rule

Strengthening of governance indicators

A negative rating action may be prompted by:

Substantial deviation from the fiscal rule

Material decline in exports, above 10 percent year on-year

End of ECB’s government bond guarantee

Appendix 1. Peer-analysis materials

General government debt / GDP (%)

Source: Eurostat

R&D spending / GDP (%)

Source: Eurostat

Appendix 2. Major sovereign indicators

Indicators

2014

2015

2016

2017

2018_F

GDP, mln USD

101109

87545

89806

95938

111483

GDP growth rate, %

2.8

3.9

3.3

3.4

4.0

GDP per capita, ‘000 USD.

18.7

16.1

16.6

17.7

20.5

Population, mln

5.4

5.4

5.4

5.4

5.4

Unemployment, %

13.2

11.5

9.7

8.1

6.8

Labor force, mln

2.7

2.8

2.8

2.8

2.7

Personal income, USD (mean equalized net annual)

9056

7925

7773

9247

9574

Consumer inflation, Dec/Dec, %

-0.1

-0.5

0.2

2.0

2.9

Consumer inflation, year-average, %

-0.1

-0.3

-0.5

1.3

2.6

Public debt to GDP, %

53.5

52.3

50.9

50.4

49.0

Wider public debt to GDP (incl. quasi-government sector), %

56.8

55.1

55.4

54.8

53.2

External debt to GDP, %

67.7

77.0

82.1

98.1

86.2

M2/International Reserves (%, end-year)

22.3

20.3

20.6

19.8

16.3

Gross Domestic Investment to GDP, %

22.0

24.2

22.6

22.9

23.8

Loans to economy, bln USD

90.8

88.8

93.9

121.2

122.9

National Fund, bln USD

n/a

n/a

n/a

n/a

n/a

International reserves, bln USD

2.6

2.9

2.9

3.6

4.5

Trade balance, bln USD

3.2

1.4

3.0

3.5

2.9

Exports, bln USD

84.6

79.7

81.0

98.4

102.0

Imports, bln USD

81.4

78.3

78.0

94.9

99.1

Current account to GDP, %

1.1

-1.7

-1.5

-1.5

-0.3

Appendix 3. List of material data sources

International Monetary Fund

World Bank

Bank for International Settlements

Eurostat

Statistic Office of the Slovak Republic

National Bank of Slovakia

Regulatory disclosure

The unsolicited credit rating and outlook were issued in accordance with ERA methodology for sovereign entities in the version from July 4, 2018 (available at www.euroratings.co.uk, section Methodology). In the same section, there is a rating scale, including an explanation of the importance of each rating category, and a default definition. Information on the rate of historical failure is available at www.cerep.esma.europa.eu, and the explanatory statement of the meaning of those default rates is available at www.euroratings.co.uk (Regulatory Framework/Disclosure). This rating is issued as an unsolicited rating, i.e., was not initiated by the rated entity or a related third party. The rated entity did not participate in the rating process and the information and documentation for its development was obtained from publicly available sources in accordance with ERA methodology. ERA did not have access to the rated entity’s internal documents. ERA, in the context of routine care, verified all sources entering the rating process. ERA considers the scope and quality of the information entering the analytical process to be sufficient to assign a credit rating. The disclosure of the unsolicited rating and outlook was preceded by the approval of the Rating Committee. No actual or potential conflicts of interest have arisen. Since July 30, 2012, ERA has been a registered credit rating agency according to the Regulation of (EC) No 1060/2009 of the European Parliament and of the Council of September 16, 2009 on credit rating agencies.